Seven changes new revenue standard may bring

The prospect of preparing for a historic, game-changing revenue
recognition standard at a huge, global public company is a bit
daunting for GE Technical Controller Russell Hodge, CPA.

“I’ll admit to it being a little bit overwhelming to us,” Hodge
said. “We have $150 billion of revenue and so many diverse, different
business models. It’s a tough question. It’s a tough thing to think about.”

The new, converged revenue recognition standard that’s in the final
stages of development by FASB and the International Accounting
Standards Board is expected to lead to at least some changes in
financial reporting for virtually all entities that use U.S. GAAP or IFRS.

The boards are scheduled to release the standard in the first
quarter of 2014. Hodge and other panelists at the AICPA Conference on
Current SEC and PCAOB Developments earlier this month described in
detail some of the changes companies may face in moving from the
industry-specific guidance in U.S. GAAP to one principles-based standard.

Christopher Bolash, CPA, a partner in EY’s Financial Accounting
Advisory Services practice, encouraged CPAs to start thinking about
the standard even before it is issued. He urged companies to build a
project team and a plan, and take inventory of major revenue streams
so they will be ready to begin implementation when the final standard
is issued.

Here are some of the changes the panelists said companies may need
to wrestle with under the new standard:

1. Updated criteria for contract determination

For a contract to exist under the new guidance, Bolash explained, an
arrangement must have:

Commercial substance, which means changes in cash flows would
be expected as a result of the arrangement.

Approval and commitment to perform obligations from both parties.

Identification of rights and responsibilities—and payment terms—by
both parties.

This is a bit different from the “persuasive evidence of
arrangement” criteria some companies use in U.S. GAAP today, Bolash
said. Companies will need to examine whether their arrangements meet
the new criteria to be considered a contract. They may need to change
their accounting policies if previously they only relied on the
persuasive evidence of arrangement to determine whether a contract existed.

2. New depictions of contract modifications

The standard will include a new framework for reporting on contract
modifications that could cause challenges and be a huge undertaking
for some companies. Companies that retrospectively adopt the new
standard will need to consider past contract modifications in
determining contract balances.

GE has many 15- and 20-year contracts that have changed over the
years, and that could lead to implementation difficulties, Hodge said.

“That’s going to be a huge change,” he said. “Having to go back and
retrospectively restate those, thinking about all the modifications
that have occurred in those contracts over the last 15 or 20 years, is
overwhelming to think about.”

3. Identifying different performance obligations

Companies that have followed long-term contract accounting under
AICPA Statement of Position 81-1 typically think of the contract as
the unit of account, Bolash said. But the new guidance may cause
companies to find components of a contract that they would identify
separately and think about differently, perhaps with a new recognition
pattern for those components.

“We believe at Microsoft that we’ll be pulling forward a lot of
revenue because we’re going to be separating our performance
obligations, the license separated from the upgrades—when available—or
other services,” said Microsoft Director of Corporate Revenue
Assurance Stacy Harrington.

4. Judgment in selling price estimate

A lot of judgment will be involved in the estimation of the selling
price, Hodge said. He said it will be important for management to
establish and maintain sound policies, adjusting where necessary.
Documenting the judgments also will be important.

Harrington said companies will have to build out an infrastructure
to support their estimates. Identifying key credits such as rebates,
price protections, and returns—and booking the reserves for them—will
be important, Harrington said.

“I think this is going to be a change for a lot of companies because
they can estimate,” Harrington said. “… They have the history of the
refunds and returns, et cetera, so they are going to have to recognize
revenue as a sell-in model.”

5. New depiction of transfer over time

Many companies—particularly in the aerospace and defense
industry—use percentage of completion in a “units-of-delivery” method
under U.S. GAAP to depict transfer of goods or services over time to a
customer, Bolash said.

Under the new guidance, Bolash said, shifting to a “cost-to-cost”
approach may provide more accurate depiction of the transfer of goods
over time. The cost-to-cost method presents the ratio of costs already
incurred compared to the expected total cost of completing a project.
But that might lead to operational challenges.

“Some companies like to use the output measures because you can
objectively identify it, and it drives the right operational behavior,
right?” Hodge said. “You get the unit done and out the door, and
that’s your milestone. I think that’s going to create some challenges
for [some] companies.”

6. Change in performance incentives

A switch from “units of delivery” to “cost-to-cost” may create a
need for different performance incentives for operations, Bolash said.

That’s one of a handful of areas where it may be important to make
sure employee incentives are changed, if necessary, to reward behavior
that benefits the company under the new revenue standard, panelists said.

For instance, a company that is newly recognizing revenue upon sales
to a reseller would want to make sure that commission policies do not
incentivize the sales force to engage in channel stuffing, Harrington said.

“If the nature of your revenue recognition is changing, maybe you
need to revisit your commission structures,” Bolash said. “And there
are all kinds of different approaches in terms of a commission on
booking, a commission on collecting cash, or revenue recognition.”

7. New disclosures

Even companies that do not anticipate recognition or measurement
differences are likely to have significant changes in the disclosures
they need to make under the new standard, Bolash said.

Disclosures will include disaggregation of reported revenue,
narrative explanations of changes in balances, and information about
performance obligations, according to the panelists. Significant
judgments will need to be explained, particularly those regarding the
timing of satisfaction of performance obligations, and the
determination of transaction price and allocation to performance
obligations, the panelists said.

“Start thinking about, what are those disclosure requirements?”
Bolash said. “Take an inventory of those disclosure requirements. Do
you have the systems and processes in place today to capture that
information? Otherwise, start thinking about what you need to do to
build that out.”

Taken as a whole, Hodge said, the changes and implementation are
going to require a lot of resources for some companies. The effort
will require the attention of many functions across the organization,
and the implementation landscape will develop over time as companies
get answers to pressing questions from the boards’ transition resource
group, Hodge said.

“It’s going to be a significant implementation effort,” Hodge said.
“Even if you look at it and you don’t expect there to be a significant
financial statement impact … it’s still a huge undertaking because
you’re looking at all of your contracts through a new lens.”